Link trading is the task of getting links to your site on other sites by trading. umm. links. This is done to get more traffic to you web site.

Link trading creates more traffic in two main ways, increased search engine rankings and also from the traffic the links themselves generate from people clicking on them.
Link Trading and Search Engines
Trading links helps search engine rankings because the algorithms that determine rankings factor in the number of sites that link back to the site to be ranked. The logic is that sites that have many links pointing back to it must be relevant and good in some sense, and are therefore ranked higher in the engines.
How to Trade Links
Now that we know what link trading is, how is it done? There are many methodologies. Since link trading can involve many contacts, requests and link categorizations, it is best to use software to handle your link trading campaign.

Link Trading Software
The software you choose should allow you to create a link directory, ad links to that directory, send requests to have your link posted on other sites and a method for keeping track of responses.
Link Trading Process
The general process begins when the site owner identifies a site which he or she would like to trade links with. Generally, these sites should be relevant to the topic of your site, or at least have a section dedicated to the topic of your site. Trading links with huge numbers of unrelated sites will actually hurt your search engine rankings in most cases. Also, usually it is a good idea to look for well-ranked sites to trade links with. The importance of a well-ranked site's link to your site in search engine algorithms will be greater than those of not so well ranked sites.
After the site to trade links with is located, a link to that site is posted on your site. Sometimes the link would be posted on a different site than the site wishing to get a link back. This produces non-reciprocal links, which weigh heavier in search engines.
After the link is posted, a request is sent that a link back be posted, explaining that if a link back is not created, the original link to the prospects site is likely to be removed.

If a link is returned, then the trade is marked as successful and each of the link traders has one more site linking to it. Other wise a follow up is sent. If the follow up still does not result in a link back, often the link would be removed.
Link Trading Etiquette
Asking to trade links without posting a link to the site you are wishing to trade with is bad form. The prospect is likely to think "If this person has not already posted a link to my site, what will motivate them to do so when I post a link to their site?" Many people will not even respond to a link request whereas the link has not yet been posted.
This is of course only a brief introduction to link trading. In short, effective link trading requires organization, persistence and time, yet is often well worth the effort.